Myopic governments and welfare-enhancing debt limits

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Author: Malte Rieth
Date: Jan. 2014
Publisher: Elsevier B.V.
Document Type: Article
Length: 171 words

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To link to full-text access for this article, visit this link: Byline: Malte Rieth Abstract: This paper studies welfare effects of a soft borrowing constraint on sovereign debt. The constraint is modeled as a proportional fine per unit of debt in excess of a specified reference value, resembling features of the Stability and Growth Pact. Sovereign debt is the result of myopic fiscal policy. It reduces welfare in the absence of lump-sum taxes. The paper shows that the borrowing constraint enhances welfare by reducing long run debt. In an economy calibrated to a generic OECD country, the maximum attainable welfare gain of debt consolidation, which is induced by imposing the optimally parameterized constraint, amounts to 0.5% in terms of consumption. The short run welfare costs of the constraint, which arise from restricting the use of debt to smooth taxes, are quantitatively negligible. Author Affiliation: German Institute for Economic Research (DIW Berlin), Mohrenstrasse 58, 10117 Berlin, Germany Article History: Received 17 January 2012; Revised 25 May 2013; Accepted 11 October 2013

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Gale Document Number: GALE|A353941601